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Will Tax Reform Help or Hurt Housing ETFs?

Sanghamitra Saha
Is (LXFR) Outperforming Other Industrial Products Stocks This Year?

The homebuilding sector has been in great shape this year. Builders’ confidence is hovering around the highest level in more than 18 years this month. The NAHB/Wells Fargo Housing Market Index increased 5 points in December to 74, marking the third successive rise, as per analysts from Wells Fargo. December witnessed the biggest monthly expansion since March.

Housing starts in the United States touched their highest level in longer than a year in November, mainly due to a rise in single-family home construction in the South and West. New single-family home construction in those regions touched their highest monthly rates since July 2007. Overall, heading into 2018, the U.S. housing sector appears sturdy. At least, the latest pool of data including the home sales gives such cues.

What Is the Impact of Likely Tax Reform?

But there is a key concern about the impact of the tax reform. Homebuilders are expected to lose as the new tax bill lowers the value of the mortgage interest deduction to $750,000 from $1 million, thereby limiting the purchase of luxury homes.

This in turn would impact the profitability of the homebuilders, leading to a decline in the stocks and ETFs. Still, J.P. Morgan believes that on average, homebuilders will experience a 17%  EPS increment from the tax reform in 2018, considering a 25% corporate tax rate across the board. Plus, the research house indicated that both single-family housing starts and new home sales will likely expand around 10% in 2018 (read: ETFs to Bet on the Final Tax Bill: What Hot, What's Not).

Effects of Interest Rates

As we all know, housing stocks underperform in a rising rate environment, so it is time to think how these ETFs will behave in 2018 given the impact of the tax reform and a hawkish Fed. J.P. Morgan expects a 30-basis-point rise in the 10-year Treasury by the end of 2018 to 2.7% which won't leave a material impact on the housing sector.

The monthly average commitment rate was 3.92% in November 2017, up from 3.77% in the year-ago period, but still lower than the levels seen at the start of the year (4.15%).

Valuation in Going into 2018?

According to J.P. Morgan, the housing sector began 2017 trading at 9x 2018E EPS and is now trading at around 11.7x 2019E EPS. This gives cues of "more reasonable, albeit still relatively full valuation (read: Housing ETFs to Buy in 2018).”

ETFs to Tap

If you believe that the economy will pick up and the housing market will recover in the coming days, you can bet on SPDR S&P Homebuilders ETF XHB and iShares U.S. Home Construction ETF ITB. You can also consider PowerShares Dynamic Building & Construction Fund PKB. The funds are up 28.3%, 54.6% and 28.3% in the year-to-date frame (as of Dec 19, 2017). The funds have a Zacks ETF Rank #2 (Buy).  

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SPDR-SP HOMEBLD (XHB): ETF Research Reports
 
ISHARS-US HO CO (ITB): ETF Research Reports
 
PWRSH-DYN BLDG (PKB): ETF Research Reports
 
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